Should You Consolidate Federal Student Loans?

Consolidating your student loans can save you time and money. Find out how to consolidate and pros and cons of each path.

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A college education doesn’t come cheap, as 44 million Americans can attest.

Collectively, they have borrowed $1.5 trillion to score a diploma and paying it back hasn’t been easy. About one in 10 default on their student loans and though the average repayment time varies by amount owed, it’s safe to say it’s probably going to take at least 10 years and might take as long as 30 years.

Members of the class of 2019 who took out student loans, owe an average of $31,172 and their payments are just under $400 a month. That is a sizeable and unwelcome graduation gift so it’s important to know how to minimize the damage.

If the money you borrowed was all federal loans, you can find easier repayment options by applying for a Direct Consolidation Loan.

If some or all of your student loans were from private lenders, you will have to use a refinancing program to achieve similar results.

What Is Student Loan Consolidation?

Consolidation is a way to make repaying student loans more manageable, and possibly less expensive. You combine all your student loans, take out one big consolidation loan and use it to pay off all the others. You are left with one payment to one lender every month.

The typical student borrower receives money from federal loan programs every semester in school. It often comes from different lenders, so it is not unusual to owe money to 8-10 separate lenders by the time you graduate. If you continue borrowing for graduate school, add another 4-6 lenders to the mix.

Each of these student loans has its own due date, interest rate and payment amount. Keeping track of that kind of schedule is complicated and part of the reason so many have defaulted. It’s also why student loan consolidation is such an attractive solution.

Federal loans can be consolidated in the Direct Consolidation Loan program. You combine all federal student loans into one loan that has a fixed interest rate. That rate is derived by taking the average of the interest rates on all federal loans and rounding the rate up to the nearest one-eighth of a percent.

Though this method will not lower the interest you pay on federal loans, it will keep open all repayment and forgiveness options. Some lenders do make it possible to reduce the interest rate by making direct payments or by qualifying for a reduction by making on-time payments over an extended period of time.

Difference Between Student Loan Consolidation and Refinancing

Refinancing student loans is similar to the Direct Consolidation Loan program in that you bundle all your student loans into one loan and make a single monthly payment, but there are important differences that you should look at before making a decision.

Refinancing, sometimes called private student loan consolidation, is primarily for private loans and can only be done through private banks, credit unions or online lenders. If you borrowed from both federal and private programs and want to consolidate the whole batch, that only can be done through a private lender.

The major difference between refinancing and Direct Loan Consolidation is that with refinancing you negotiate a fixed or variable interest rate that should be lower than what you were paying for each loan individually. The lenders take into account your credit score and whether you have a cosigner in determining your interest rate.

However, if federal loans are part of your refinancing, you lose the repayment options and forgiveness programs they offer, including deferment and forbearance. Those last two items can be crucial if you run into financial complications while repaying your loans.

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Pros of Direct Loan Consolidation

There are many good reasons to consolidate through the Direct Loan Consolidation program, not the least of which it keeps you alive for one of the income-based plans such as REPAYE (repay as you earn), PAYE (pay as you earn), IBR (income-based repayment) and ICR (income-contingent repayment).

Here are more pros for the Direct Loan Consolidation program:

  • One payment.Consolidation means combining all your federal loans into one. That loan will be serviced by one lending institution and requires one monthly payment. If you still send payments through the mail, this will save you some money on stamps and envelopes, not to mention saving a whole lot of time and aggravation.
  • Avoid default.Consolidating loans will allow you to change the terms and lower your monthly payment. This should help avoid default if you are struggling to make your payments each month. If you default, your credit score will take a major hit, and it remains on your credit report for seven years.
  • Fixed interest rate. If you have a lot of loans, you probably have a lot of different interest rates. A consolidated loan has a fixed rate for the life of the loan. The interest rate on a consolidated loan is based on the average of the interest rates on all the loans being consolidated, rounded up to the nearest one-eighth of 1%.
  • Lower payments. Consolidation offers a variety of repayment plans, most of which extend the terms of the loan from 10 years to 15, 20 or even 30 years. A longer term loan can lower the monthly payment by as much as 50%, making it more affordable while you get going in the working world. It’s also possible to get reduced interest rates and that too will reduce monthly payments.
  • Multiple repayment plans. A Federal Consolidated Loan is eligible for a number of repayment plans and borrowers are free to choose the plan that best suits their situation.  Borrowers also can switch repayment plans at any time. Repayment plans for Federal Consolidated Loans include: Standard (10 years), Extended (25 years), Graduated (start low, increase every two years for between 10 and 20 years) and Income-based (10-15% of your discretionary income).
  • Deferment/forbearance options increase. Because a Direct Consolidation Loan is a new loan, it restarts the clock on deferments and forbearance for up to three years. Also, if you can’t repay a Federal Consolidation Loan because you are looking for a job, you can apply for unemployment or economic hardship deferment and delay paying for up to three years.
  • No minimum or maximum.There is no minimum amount to qualify and no maximum amount that can be consolidated.
  • Protecting credit. Consistent payment of student loans has a positive impact on your credit score. Missing just one payment will hurt your credit score. Paying one bill per month instead of 10-15 should lessen the chance of negligence. Avoiding default, as mentioned above, will help protect your credit score as well.
  • Automatic debit. If the only reason you’re consolidating is because you can’t keep up with monthly payments to multiple lenders, set up an automatic debit from your bank account to pay the bill every month and be done with it. Just be sure that account is well funded every month.
  • Loan discount. Some banks offer discounts on your interest rate if you set up an automatic debit. A few were offering 1% discounts on interest rates after 36 months of on-time payments for as long as the on-time payments continued.

Cons of Student Loan Consolidation

There are two sides to every story and here is the other side to consider before going into the Direct Loan Consolidation Program:

  • Pay more in interest over time. If you consolidate and extend the loan term, you could pay a lot more in interest. The longer you wait to pay off the loan, the more interest you end up paying. Also, if you’re still paying on a student loan for 20-25 years, it could hinder or even block opportunities to buy a home, relocate, invest in a business or even purchase a new automobile. Paying off a loan as quickly as possible saves time and money. It’s as simple as that.
  • Rounded-up interest rate.Direct loan consolidation adds one-eighth of 1% to the weighted average interest rate. The new rate is determined by a weighted average of all the other rates, which considers the amount owed, and adding 0.125%. If your larger loans have a higher rate, then the weighted average will be a little higher than a simple average.
  • No private loan consolidationStudent loans from private lenders or institutions can’t be part of the Federal Consolidation loan program. On the other hand, certain private lenders allow loan consolidation that could include federal loans, but the interest rates are usually much higher on private consolidations.
  • Lose some benefits. If you have made payments toward Public Service Loan Forgiveness, consolidating your loans will restart the clock on qualifying. Also, you may loses benefits on other programs, notably Perkins Loans if the Perkins loan becomes part of a Federal  Direct Consolidation Loan. Read all the terms and conditions of your loan before consolidating.
  • Lost “grace” period. Borrowers typically get a six-month window before having to start repaying student loans. That goes out the door when you consolidate your loans. You typically start paying two months after your loan consolidation is approved.
  • Lender benefits gone. Some lenders give reduced interest rates or principal reductions if borrowers meet certain conditions. Those benefits are lost when your student loans are consolidated.
  • No do overs. You can only consolidate student loans one time. If interest rates fall after you consolidate, tough break! You’re stuck with the interest rates you agreed to during consolidation.

Should You Consolidate Student Loans?

If you have missed payments because you struggle keeping up with multiple loan servicers and multiple repayment dates, consolidation or refinancing is a valid choice. Making one payment every month instead of many payments makes life simpler.

You can go through the Direct Loan Consolidation program because it lets you keep the door open for income-based repayment options that result in lower monthly payments.

However, it is important to know that if your payments are part of qualifying for any forgiveness program, the clock restarts when you consolidate your debts. For example, if you made three years of qualifying payments for Public Service Loan Forgiveness, then consolidate your loans, you would lose the three years of qualifying payments and the clock would start over again.

The big issue for most borrowers is can they afford the monthly payment? That’s what consolidation and refinancing are remedies for: giving you a payment that doesn’t break your budget every month.

However, if you’re making enough money right out of the gate and very dedicated to repaying your loan, the fastest, most efficient method is to go with the standard repayment program and get it done in 10 years … or less!

About The Author

Max Fay

Max Fay has been writing about personal finance for for the past five years. His expertise is in student loans, credit cards and mortgages. Max inherited a genetic predisposition to being tight with his money and free with financial advice. He was published in every major newspaper in Florida while working his way through Florida State University. He can be reached at [email protected].


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